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01 November 2018

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On Monday, October 1, Chairman of the Commodity Futures Trading Commission (the CFTC) J. Christopher Giancarlo released Cross-Border Swaps Regulation Version 2.0, a white paper (the White Paper) which calls for dramatic overhaul to the CFTC's extraterritorial application of Title VII of the Dodd-Frank Act[1] (Title VII).

The CFTC is expected to propose new cross-border rules based on the principles set out in the White Paper, but the timing for these proposals is still uncertain.

The CFTC's extraterritorial jurisdiction under Title VII is dictated by section 2(i) of the Commodity Exchange Act (CEA),[2] which calls for the application of Title VII to activities that have a "direct and significant connection with activities in, or effect on, commerce of the United States." This standard has been applied through a combination of rules[3] and guidance, with the Cross-Border Guidance[4] controlling the extraterritorial application of the majority of Title VII. Additional rules were proposed in 2016[5] which were intended to replace the reliance on the Cross-Border Guidance, but these rules were never finalized.

The White Paper highlights a number of issues with the current Cross-Border Guidance, some substantive and some procedural:

The Cross-Border Guidance and associated no-action letters are not subject to formal notice and comment in accordance with the Administrative Procedure Act. The White Paper indicates that the CFTC does not believe the CFTC should be following such informal procedures for making wide-reaching policy;

It is unwieldy. The Cross-Border Guidance is described in the White Paper as "unduly complex" and "operationally impractical."[6] The Cross-Border Guidance as published spans 83 pages in the Federal Register.

The authors of the White Paper conclude that the overarching approach of the Cross-Border Guidance is, in many respects, incorrect. The Cross-Border Guidance is "over-expansive" and reliant on a substituted compliance regime that is "somewhat arbitrary" and which shows "insufficient deference to non-U.S. regulators that have adopted comparable G20 swaps reforms."[7] The White Paper generally (though not exclusively) calls for a reduction in Title VII's interpreted extraterritorial reach. The White Paper also calls for a more holistic approach to substituted compliance determinations that is more consistent with the CFTC's "long-standing approach of showing comity to competent non-U.S. regulators."[8]

The White Paper therefore calls for a new cross-border framework for Title VII built on the following principles:

Categorizing regulations according to whether they are (i) intended to mitigate systemic risk, or (ii) designed to address particular market and trading practices that may be adapted appropriately to local market conditions.

Pursuing "multilateralism, not unilateralism," and generally taking a strict approach toward substituted compliance with respect to rules intended to mitigate systemic risk.[9] For these rules the White Paper advocates for comity, rather than strict uniformity.

Ending the current division of global swaps markets into marketplaces which cater to U.S. persons and those which do not (out of a desire to avoid U.S. regulation). The White Paper calls for the CFTC to work towards creating a unified marketplace across all jurisdictions that have adopted comparable regulations to address the G20 commitments. To this end, the CFTC would approach the extraterritorial application of each Title VII regulation by analyzing whether the swaps activity is taking place within (i) the U.S., (ii) a comparable jurisdiction, or (iii) a non-comparable jurisdiction.

Ensuring that the CFTC is a "rule maker, not a rule taker" when overseeing U.S. markets.

Acting, in respect of rules designed to address particular market and trading practices that may be adapted appropriately to local market conditions, with deference to non-U.S. regulators in jurisdictions that have adopted comparable G20 swaps reforms, and taking a more flexible approach toward substituted compliance.[10]

Encouraging regulators of non-U.S. markets with significant swaps trading activity to adopt comparable regulations to U.S. rules in the context of the G20 commitments, so as to (i) minimize the risk that activities in these jurisdictions pose to the U.S. market, and (ii) reduce the availability of off-shore havens for U.S. entities to escape CFTC jurisdiction.

How exactly these principles will manifest once put into rule form is not entirely clear at this point, given how many rules are currently covered by Title VII and the Cross-Border Guidance. Which rules the CFTC will ultimately deem system risk mitigators and which will be deemed designed to address particular market and trading practices is unclear at this time, as is how exactly the CFTC intends to draw the lines between when U.S. rules should apply and when they should not. However, the White Paper does address at a high level how it recommends the CFTC approach certain Title VII requirements:

Non-U.S. CCPs. The White Paper calls for the CFTC to "expand the use of [its] exemptive authority" for non-U.S. CCPs subject to comparable regulation in their home countries.[11] The CFTC has, to date, granted four registration exemptions to non-U.S. CCPs.[12]

Non-U.S. Trading Venues. The White Paper describes the global swaps market as being segregated into two types of local marketplaces: those that cater to U.S. persons, and those that do not. To remedy this the White Paper calls for the CFTC to exempt from swap execution facility registration those non-U.S. trading venues located in jurisdictions with comparable regulations.[13] This is in line with the 2017 "Common Approach" between the U.S. and the E.U. outlined in October 2017.[14]

Non-U.S. Swap Dealers. As it stands, the Cross-Border Guidance generally requires covered swap dealing transactions that involve U.S. persons (as such term is defined in the Cross-Border Guidance) to be counted against a dealing entity's swap dealer de minimis threshold. The White Paper argues that in many such cases, the result is that swap dealing activity which does not have a "direct and significant" connection to the U.S. market is counted, which runs counter to Section 2(i) of the CEA. Accordingly, the White Paper calls for a modification in scope regarding which transactions must be counted toward an entity's de minimis threshold: utilize the simplified categories found in the Proposed Rules (e.g. no "conduit affiliate" concept) while retaining the exemptions found in the Cross-Border Guidance (including the exemption for swaps with registered non-U.S. swap dealers, which was absent from the Proposed Rules).

Clearing and Mandatory Trade Execution. The White Paper calls for different treatment of the clearing requirement, which in the CFTC's view is designed to mitigate systemic risk and therefore warrants stricter comparability for substituted compliance, and the trade execution requirement, which in the CFTC's view pertains to local market structure and trade practice and therefore warrants more flexibility when making a substituted compliance determination. This is in contrast to the current regime, which generally treats clearing and trade execution as inextricably linked requirements.

ANE Transactions. A non-U.S. swap dealer's transactions which are arranged, negotiated, or executed in the U.S. (ANE Transactions) are currently the subject of a 2013 advisory,[15] which was not subject to the Administrative Procedure Act, and which concludes that ANE Transactions are subject to Title VII's transaction-level requirements. ANE Transactions have subsequently been addressed by annual no-action letters (the most recent being Letter 17-36[16]), which are again not subject to the Administrative Procedure Act, and which provide limited relief for non-U.S. swap dealers from complying with transaction-level requirements for ANE Transactions, effectively freezing the impact of the 2013 advisory. The White Paper argues that ANE Transactions need to be specifically addressed in future rulemaking, and that arranging and negotiating should be treated differently from executing. Swaps that are executed in the U.S. ought to always be subject to U.S. swap execution rules. Swaps that are arranged or negotiated in the U.S. would also generally be subject to U.S. transaction-level requirements due to the fact that U.S. agents add "knowledge and expertise of local markets and conditions" which "makes the swaps effectively… U.S. trade[s]."[17] However, the White Paper leaves open the possibility that the CFTC would issue relevant comparability determinations and allow for substituted compliance with respect to ANE Transactions.

The White Paper serves as a first, albeit major, step toward the CFTC's rewriting of its extraterritorial application of Title VII. The timeline for when new rules will be proposed is not set out in the White Paper, but Allen & Overy will continue to closely monitor this space for anticipated developments.

[14] Available at https://www.cftc.gov/sites/default/files/idc/groups/public/@newsroom/documents/file/dmo_cacdtv101317.pdf.

[15] Applicability of Transaction-Level Requirements to Activity in the United States, CFTC Letter No. 13-69 (Nov. 14, 2013) available at https://www.cftc.gov/sites/default/files/idc/groups/public/@lrlettergeneral/documents/letter/13-69.pdf.